Common Factors in Euro-denominated Emerging Market Bond Spreads

Abstract

The growth in euro-denominated bond debt issued by emerging market sovereigns picked up considerably after the Asian currency crises. However, while many emerging market governments now have outstanding euro-denominated issues, the market for this debt remains considerably smaller and less liquid than its US dollar counterpart. This has implications for both investors and sovereigns as they try to balance liquidity and cost of capital considerations against portfolio diversification and exchange rate movements. Broadly speaking, spreads on emerging market bonds across countries tend to move in tandem over time. This chapter takes an introductory look at the market for euro-denominated sovereign debt, and investigates the degree to which spreads on euro-denominated emerging market sovereign debt react to common forces. Following a similar analysis of the US dollar market in McGuire and Schrijvers (2003) (hereafter MS2003), we use principal factor analysis to determine the number of common factors that drive movements in spreads, and then seek to assign meaning to these factors through simple correlations with economic variables.

Citation

McGuire, P. and Schrijvers, M. (2006), "Common Factors in Euro-denominated Emerging Market Bond Spreads", Batten, J.A. and Kearney, C. (Ed.) Emerging European Financial Markets: Independence and Integration Post-Enlargement (International Finance Review, Vol. 6), Emerald Group Publishing Limited, Leeds, pp. 261-280. https://doi.org/10.1016/S1569-3767(05)06011-5